LIBOR Scandal: Resurrecting Demons

Posted in Finance Articles, Total Reads: 1098
, Published on 27 August 2012

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LIBOR, if the word doesn’t ring any bell in your ears then you must have returned from a trip to another planet. Welcome back to earth, a planet captured in the shackles of greedy minds.Even after weeks of being the blue eyed boy of economic reporters across the world and eating away a lot many pages of your daily newspaper, the LIBOR Scandal refuses to die down. But the question that arises is why the world is so fascinated about such a simple sweet-sounding word. Well, the article tries to answer such questions of yours.

Libor is an acronym for London Inter-Bank Offered Rate.The history of LIBOR dates back to 1980s, when a need of benchmark for lending rates was being felt. Without a benchmark, calculating prices for financial products such as options and interest swaps was fast becoming a herculean task. As a result, work on creating a benchmark commenced, culminating with the birth of LIBOR in 1986.

LIBOR is stated as the average interest rate at which banks can borrow funds from other banks in the London interbank market. It applies to loans with maturity period ranging from overnight to 12 months. But how is LIBOR fixed? The authority of fixing LIBOR is bestowed upon British Bankers' Association (BBA). BBA takes data from a panel of banks which are felt to be representatives of London Money Market. These banks are selected only if they meet the stringent criteria like money value, reputation etc. set by BBA.

Once a part of the panel, these banks have to report daily to BBA about the rate at which they are willing to borrow loan. These are only the hypothetical values and not based on actual transactions. Once BBA (in association with Thomson Reuters) has collected the rates from all panel banks, it eliminates highest and lowest 25% values. An average of the remaining values is calculated. This average is called the LIBOR.

All said and done about LIBOR but one wonders why there is so much fuss surrounding it when it is related to just a single country? That is exactly not the case. Firstly, it’s not just a country; it’s a country which forms the largest chunk of the overall global forex daily trading. Secondly, the banks which are a part of the panel include heavyweights like Citigroup, JPMorgan Chase, Deutsche Bank, Barclay’s etc. It is a universal fact that these banks are to the financial sector what sun is to the solar system.

One can well imagine the gravity of the problem, even if one of these fails. Thirdly and most importantly, LIBOR acts as a basis not only for inter-bank loans but also a basis for the loan of your favorite car, your dream house and other such loans and mortgages. Thus an increase or decrease in LIBOR leads to corresponding rise or fall of cost of borrowing, affecting people at large. To cut the long story short, around$350 trillion is the amount which uses LIBOR as the reference rate. You can now yourself feel the impact LIBOR possess.

One question that is still lurking in the darkness is why and how banks played with LIBOR. A simple one word answer exists for the why part and it is called GREED. Greed which is contagious was successful in luring even the top-notch bankers.The how part is explained ahead. It is alleged (allegation nearing towards confirmation) that the top banks which contribute in the calculation of LIBOR submitted a false rate to BBA. This is now what is famously, rather infamously, called the LIBOR SCANDAL.

The banks distorted LIBOR by submitting a lower or higher rate than the actual rate and thereby making profits. A higher LIBOR signifies that banks lack trust and confidence in each other whereas a lower LIBOR signifies financial stability. The banks reportedly rigged LIBOR to present themselves as financially strong inspite of going through a rough patch. They did so in order to lure investors and in the process affected trillions of dollars of financial products.

The LIBOR issue was brewing up for quite a time, with warnings coming from various sectors.But the scandal came to the fore when Barclay’s accepted its wrongdoings and agreed to pay around $452 million as a fine for manipulating LIBOR. The scandal didn’t end there. As of now, it has cost the top three executives of Barclay’s their jobs, including the CEO Robert Diamond. The issue has gathered much limelight to be kept under wraps and it is a matter of time when some of the other big names start pouring in. Fingers are already being raised on some of the regulators and government officials.

The British Government and executives of other top banks are leaving no stone unturned to come out clean. The economy which was already reeling under the global recession now has a plethora of issues which might stymie its recovery. The reputation of bankers has taken a beating. Once looked as the guard of your money with people reposing immense faith in them, is now looked with an eye of suspicion. A time when demons of the debacle of Lehman Brothers were yet to be exorcised, another scandal has cropped up. This has filled people with an overwhelming sense of outrage and has done a serious damage to their psyche.

In such grave circumstances, the government and the banks need to do much more than simply suppressing the matter. They need to take the responsibility instead of keeping the skeletons in the closet. They need to act (and act swiftly) before the basic pillar-trust-on which our economy stands collapses. Till then, caution is the line to follow for pawns like us or else be prepared to be crushed under the feet of big players.